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LIBOR - Dear CEO letter

Transition from LIBOR to Risk Free Rates – Dear CEO Letter

This week the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) wrote to the CEOs of large banks and insurance companies, regarding the ongoing global benchmark reform effort mandated by the Financial Stability Board (FSB), specifically the transition from LIBOR to alternative rates.

The purpose of the letter (PDF 278 KB) is to seek assurance that firms' senior managers and boards understand the risks associated with this transition and are taking appropriate action now so that your firm can transition to alternative rates ahead of end-2021. The deadline for responses is Friday 14 December.

The letters were sent to the largest banks and insurers in the first instance, however all firms that currently rely on LIBOR have been encouraged to read and reflect on its objectives.

Implications for firms

The message from the FCA in the speech by Andrew Bailey in July 2018 was that firms should treat a LIBOR discontinuation event “as something that will happen and which they must be prepared for”. A subsequent the letter published on 19 September 2018 underlines the determination of the FCA and PRA to ensure that firms progress swiftly with their planning for transition. This is underscored by the tight timeframe for submission of responses.

The timing of the letter is poignant from the point of view of other regulatory priorities for firms (for example Brexit, FRTB, Ring fencing and Recovery and Resolution planning). It is clear the regulators view the transition from LIBOR to alternative rates as substantial and a top priority. They are, therefore, keen to see evidence that firms have at least an understanding of the potential impacts now and that progress can continue at an appropriate pace into 2019.

The key requirements include:

  • Summary assessment of key risks relating to LIBOR discontinuation
  • Summary of mitigation plans
  • Consideration of a wide range of scenarios
  • Quantification of LIBOR exposures
  • Identification of Senior Manager(s) with responsibility for transition plans.

Given the wide range and complexity of use of LIBOR in products traded, valuation, accounting and systems used by firms, the requirement for a comprehensive assessment of prudential and conduct risk is challenging for many organisations. Some of the key risks and challenges include client impact, contract identification and management, operational risk and hedge accounting. The risks are complicated further by other variable constraints such as the relative speeds of transition across jurisdictions, and the development of markets in alternative products. The summary of risks and plans should address all of these factors. In responding to the letter, firms should be able to articulate their transition programme structure (including responsibilities), which should be aligned to the key risks and challenges identified.

Scenarios should be wide ranging and consider elements such as (and not limited to) transition timing, differing speeds of adoption of new alternative products, liquidity across currencies and products (new and existing), and implications of abrupt or unstructured discontinuation. The scenarios should be tailored to the risks and size and nature of the firm's activities.

The letter is addressed to UK regulated entities and hence the exposure in the entity may be a limiting factor, however given the global and interconnected nature of LIBOR exposures, it is likely that the FCA and PRA will be looking for group level exposures as well as entity level exposures. In any case, where group and entity level exposures to LIBOR are not yet well understood some significant effort could be required to collate exposure information.

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